The hidden impediment to school renovation

Mark J. Rozell and Paul Goldman

A major reason many Maryland jurisdictions — especially Baltimore County and Baltimore City — confront a growing problem of aging, obsolete school buildings is an obscure bit of Internal Revenue Service bureaucracy called the "prior use rule." It applies in a limited number of circumstances, one being projects to renovate certain old public school buildings.

Since 1986, this rule has forced Baltimore and other localities into one of three unpalatable choices: grossly overpay for modernizing their oldest schools; build new, often much more expensive ones; or push the problem onto the back burner, guaranteeing any eventual solution will be even costlier.

Due to the age of the city's school buildings, nearly half might qualify for the type of purely private capital modernization solution that saved 33 percent for Richmond, Va., on the cost of fully renovating a dilapidated, 60-year-old high school facility. But the "prior use rule" denies this proven solution to Baltimore.

This costs Baltimore and Maryland billions of dollars over time. Baltimore's schools CEO Andrés Alonso wants to borrow $1.2 billion to modernize run-down schools, although a recent study found it will take $2.8 billion to do all that might ultimately be necessary. Anne Arundel, Baltimore and Howard counties combined have even greater modernization needs. Architectural historian Margaret Roberts found the number of run-down schools 50 years or older in Maryland, along with other states she is studying, far exceeds previous estimates.

She concluded "this unfair IRS 'prior use rule' is costing us big time. America's schools are really old. You can't get a true 21st century education in a building designed for a 20th century curriculum."

Baltimore may soon have a chance to save itself huge sums of money. House Republican Majority Leader Eric Cantor and Democratic Sens. Jim Webb and Mark Warner, all Virginians, have joined in a bipartisan push for S. 1685, which would eliminate the prior use rule for K-12 modernization projects that meet certain criteria. This legislation is now before the Senate Finance Committee, on which Maryland's Sen. Benjamin Cardin serves.

Last month, the National Education Association endorsed S.1685, saying, "It offers a common-sense approach ... based on a 100 percent private capital investment model enacted in 1986 by President Ronald Reagan and a Democratic Congress but blocked by a little known IRS 'prior use' rule."

As Mr. Cantor noted, "a simple update to the tax code … will allow schools to leverage private capital to ... ensure that our children have the best opportunity to learn and succeed."

The bill doesn't require any appropriation of funds; indeed, it offers a way to reduce long-term federally subsidized government debt now totaling in the trillions of dollars.

How does the prior use rule harm Baltimore's schoolchildren?

Old buildings often have unexpected modernization costs. So under the "federal rehabilitation tax credit" law, investors can earn tax credits up to 26 percent of the cost of a full renovation for those "historic" buildings. K-12 schools that are 50 or more years old often meet the flexible "historic" designation. But investors aren't interested in school modernization projects.

The reason is that an entrepreneur can earn credits by turning an old school building into a new use — a luxury condo, for example — but not to modernize it, because that is a "prior use."

Consider the Catch-22: Education Secretary Arne Duncan came to Baltimore and lamented the number of run-down old schools. But the federal law created to encourage rehabilitation has been undermined by another part of the tax code. This has forced localities to use the more expensive "borrow to build" approach based on issuing school construction debt. In turn, Uncle Sam has been obligated to pay a generous, long-term federal subsidy to get Wall Street's best clients to buy the bonds.

S. 1685 offers localities a new option. With a few tweaks to make it fairer to Baltimore and other long-penalized localities, the savings — based on the market value of all tax credits earned — can approach the 33 percent achieved by Richmond using its option of sale/leaseback with an option to buy. In addition, this gives further savings to Uncle Sam, since the project doesn't require new bonds.

This K-12 construction initiative would also lead to an educational instruction initiative. Scarce local resources can be redirected to classroom needs, and communities will be able to afford 21st century schools offering the latest in learning to their children.